Optimal Contracting of Separable Production Technologies

This paper addresses the class of agency problems with a risk-neutral principal and a risk-averse agent where hidden action and hidden information (on the agent's efficiency) are jointly present. The commonly used technological assumptions - such as the monotone-likelihood-ratio property (MLRP) - are no longer sufficient to demonstrate such economically appealing properties of the optimal contract as the monotonicity of the sharing rule. We show that these regularity properties obtain for the rather wide class of production technologies that are separable in the agent's inputs. Together with ordinal properties such as monotone differences and affiliation of inputs, separability yields the monotonicity in efficiency of the agent's actions and indirect utility and thereby demonstrates the importance of these properties in stochastic contexts. We also analyze the impact of separability on the stochastic properties of the output, the principal's inference problem and the agent's tradeoffs between effort and efficiency.